What are Hybrid Mutual Funds? Types of hybrid mutual funds & Advantages of investing

When we talk about mutual funds, most investors prefer investment in pure equity funds or debt funds. But there are also investors who want the best of both worlds to limit their exposure or seek a balance.These investors seek funds that invest in both equity mutual funds and debt mutual funds. Such funds aim to provide the benefits of both types of funds at the same time trying to minimize the risks associated with them. These funds are hybrid funds and investors have multiple options for investment in hybrid funds as well. 

Given below is the basic meaning of hybrid funds and the types of hybrid funds available for investment.

What are hybrid mutual funds?

Hybrid funds as mentioned above are funds that invest in both equity funds and debt funds along with other investment instruments (like money market instruments). As per SEBI guidelines, a hybrid fund can be equity-oriented or debt-oriented depending on the scheme objective and the investment strategy of the fund manager. These funds have a lower risk profile as compared to pure equity funds as the risk is spread among different asset classes. 

What are the advantages of investing in hybrid mutual funds? 

Investment in hybrid funds has many advantages that make them a good addition to an investment portfolio. Some of the key benefits of hybrid funds are mentioned hereunder. 

1. Diversification 

The prime benefit of hybrid funds is the diversification of the fund assets. Diversification is one of the main benefits of mutual funds in general but this benefit is further enhanced in hybrid funds as the fund is inherently diversified among debt and equity apart from other asset classes. This helps in effective hedging of the overall portfolio allowing the investors to gain maximum advantage along the way. 

2. Effective risk management 

The risk in hybrid funds is spread better and hence when the equity market is facing a slump, the risk is minimized by the debt component of the fund. Therefore the overall risk of the fund is reduced as compared to pure equity funds.

3. Funds for every class of investors 

Another advantage of investment in hybrid is that there is an option for every investor class whether they are risk average or aggressive investors. They can choose from various types of hybrid funds depending on their investment objective and risk profile.

What are the types of hybrid mutual funds?

As per SEBI guidelines, hybrid funds can be classified under 7 sub-categories. The details of the same are mentioned hereunder.

1. Conservative hybrid mutual funds 

As the name suggests, these funds invest majorly, approximately 75% to 90%, in debt and debt-related instruments. The balance of the fund is invested in equity and equity-related instruments along with other asset classes as per the SID. These funds are relatively less volatile and invest in mostly fixed-income debt instruments. Therefore these funds are ideal for risk-averse investors looking for more or less stable returns. The assets of these funds usually include commercial papers, corporate bonds, government bonds, treasury bills, etc.

2. Balanced hybrid mutual funds 

Balanced funds as the name suggests, invest in both equity and debt in more or less the same ratio. The fund can invest anywhere between 40% to 60% in equity and the balance in debt or vice versa. The taxation of these funds will depend on the dominant category of assets. The goal of these funds is usually capital appreciation and the risk of these funds is lower as compared to aggressive hybrid funds. 

3. Aggressive hybrid mutual funds 

Aggressive hybrid funds are a category of hybrid funds that invest predominantly in equity and equity-related instruments which are approximately 65% to 80% of the fund. The balance corpus of the fund is invested in debt instruments and other instruments as per the scheme information document. The risk of these funds is quite high along with the potential to provide higher returns for the investors. 

4. Dynamic asset allocation funds 

These are the most fluid forms of hybrid funds. There are no set guidelines for a minimum investment in any asset class for dynamic hybrid funds. The fund can shift from 100% equity investment to 100% debt investment based on its investment strategy and market trends. The goal of the fund is to maximize investors’ wealth by investing in equity and debt and giving the benefit of automatic rebalancing of funds to the investors. 

5. Multi-asset allocation funds 

Multi-asset allocation funds allow the investors to get exposure to not only equity and debt investments but also other asset classes like gold, commodities, etc. The fund has to invest in a minimum of 3 diverse asset classes and the key feature of this fund is the minimum investment of 10% in each of the three asset classes as mentioned in the SID of the fund and as per its investment strategy. The expertise and the experience of the fund manager are quite crucial in determining the allocation of the fund among various asset classes with a view to providing maximum returns to the investors. 

6. Arbitrage funds

These funds invest a minimum of 65% of the fund in equity and equity-related instruments and are therefore categorized under equity-oriented hybrid funds. However, the key feature of the fund is that the fund manager in this case is constantly seeking opportunities to buy assets at a lower rate in one market and sell the same at a higher rate in the other. This creates perfect hedging opportunities for the investors and when such hedging opportunities are not available as per the current market trends, the fund will invest in debt instruments to lower the risk of the fund. This fund is thus a good opportunity for risk-averse investors who are looking to earn returns like debt funds but want to avoid the higher taxation on the same. 

7. Equity Savings fund 

These funds invest in equity (minimum 65% of the fund), debt (minimum 10% of the fund), and the balance in derivatives. The investment in derivatives and debt lowers the overall risk of the fund and assures more or less stable returns for the investors. The ideal investment horizon for these funds is medium-term i.e., between 2 to 3 years which allows the investors to increase their overall returns from the fund.  

How are hybrid mutual funds taxed?

The taxation of hybrid funds depends on the dominant asset class of the fund. If the fund is equity-oriented, the fund will be taxed in the line of an equity fund while if the fund is debt-oriented, the taxation of the fund will be in line with that of debt funds. The details of taxation of hybrid funds are tabled below. 

Conclusion 

Hybrid funds are an excellent addition to an investment portfolio of an investor as it gives the benefits of both equity funds as well as debt funds in a single investment. The cost of investment is therefore reduced and the investors get the opportunity to rebalance their portfolio without additional investment costs. 

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